My most recent books are the Leader's Guide to Radical Management (2010), The Leader's Guide to Storytelling (2nd ed, 2011) and The Secret Language of Leadership (2007). I consult with organizations around the world on leadership, innovation, management and business narrative. At the World Bank, I held many management positions, including director of knowledge management (1996-2000). I am currently a director of the Scrum Alliance, an Amazon Affiliate and a fellow of the Lean Software Society. You can follow me on Twitter at @stevedenning. My website is at www.stevedenning.com.

The NYT article sheds a harsh light on the management practices of industry giant HCA, which controls 163 hospitals from New Hampshire to California. HCA has made huge profits—much more than its competitors—through financial innovation without necessarily providing benefits to patients or society. HCA has succeeded in:

Charging morefor the same: New ways to get more revenue from private insurance companies, patients and Medicare by billing much more aggressively for its services than ever before; The NYT reports that “In late 2008, for instance, HCA changed the billing codes it assigned to sick and injured patients who came into the emergency rooms. Almost overnight, the numbers of patients who HCA said needed more care, which would be paid for at significantly higher levels by Medicare, surged… The change, which HCA’s executives said better reflected the service being provided, increased operating earnings by nearly $100 million in the first quarter of 2009.”

Restricting access to low-return services: New ways to reduce emergency room overcrowding and expenses; for instance by turning away with minor conditions like a sprained wrist unless they are paid for in advance. Some 80,000 patients have been turned aside in this fashion.

Increasing the quantity of lucrative services: On August 6, 2012, HCA revealed that it is currently under investigation by the Civil Division of the U.S. Attorney’s office in Miami for generating unnecessary high-cost cardiology services, the largest U.S. hospital operator disclosed Monday.

Cutting staff costs: New ways to reduce the cost of its medical staff, sometimes at the expense of patient care. The article says, “In one measure of adequate staffing — the prevalence of bedsores in patients bedridden for long periods of time — HCA clearly struggled. Some of its hospitals fended off lawsuits over the problem in recent years, and were admonished by regulators over staffing issues more than once.”

The big winners from these practices at HCA have been three private equity firms—Bain Capital, Merrill Lynch and Kohlberg Kravis Roberts & Company—that bought HCA in late 2006. According to the NYT, “HCA’s robust profit growth has raised the value of the firms’ holdings to nearly three and a half times their initial investment in the $33 billion deal…. The new owners contributed about $1.2 billion in equity outlay from funds they oversaw, borrowing around $16 billion and assuming $11.7 billion of HCA’s outstanding debt. The deal essentially doubled the amount of debt held by HCA hospitals to $26 billion by borrowing from banks and selling bonds.”

Does care improve?

For its part, HCA says that the overall quality of care has improved. The NYT article says:

“HCA says that more than 80 percent of its hospitals ranked among the top 10 percent in the country for federal quality measures, compared with 13 percent in 2006 when it went private. Last year, the company provided a $2.68 billion provision for charity care. And under the control of its private equity owners, HCA has invested around $8 billion in its hospitals in the last five years, according to Securities and Exchange Commission findings. ‘You must know that we firmly believe that there is no sustainable business model as a health care delivery system that does not have at its core the provision of high-quality patient care and services,’ HCA’s chief executive, Richard M. Bracken, has written to the NYT.”

Mr. Bracken talks about the primacy of high-quality patient care. But is it a reality? The NYT article reports:

HCA owned eight of the 15 worst hospitals for bedsores among 545 profit-making hospitals nationwide, each with more than 1,000 patient discharges, tracked by the Sunlight Foundation using Medicare data from October 2008 to June 2010.

A more fundamental question is: can high-quality patient care have primacy when the goal of the firm is to make money?

The dynamic of profit-driven innovation

In Dr. Gawande’s article in the New Yorker, we can see the dynamic of innovation in a private equity setting. Gawande describes a Big-Brother-like command center in the Steward Hospital System owned by the private equity firm, Cerberus. In some circumstances, one could imagine how such a command center might turn out to be helpful in improving care to some extent, particularly if it is operated in a negotiation mode, as described by Gawande, rather than a command center, as it is named. The command center’s director, Dr. Ernst, seems to be a conscientious well-meaning doctor. He believes he is “not telling clinicians what to do.”

But how long can this last? Steward is owned by private equity whose its explicit goal is to make as much money as possible for itself and its investors as soon as possible. Such a goal leads inexorably to top-down command-and-control style management to force the staff like Dr. Ernst to give priority to the goal of making money, since it is hardly likely that Dr. Ernst or his colleagues spent years and years in medical training with the goal of making money for Cerberus.

So if Cerberus is succeed in its goal of making money as quickly as possible, it will have to compel Dr. Ernst and his colleagues to give priority to its goal, rather than the goal that he might personally espouse, like, say, improving the health of their patients. Is it plausible that Dr. Ernst will be able to go on “not telling clinicians what to do”, when telling people what to do is the inexorable modus operandi of Steward’s private equity owner? We know from history who is going to win this battle.

Private equity is spreading in health care

Gawande is right about one thing. Big Medicine is spreading. The financial performance of HCA has been so impressive that its success inspired 35 buyouts of hospitals or chains of facilities in the last two and a half years by private equity firms eager to repeat the windfall.

Is this just the normal and inevitable capitalistic system of creative destruction, in which private equity brings capital and management and improves the performance of the organization? Is it possible to get the gains from management and capital without the alarming side-effects?

Three varieties of capitalism

One clue comes from Roger Martin, Dean of Rotman School of Management at the University of Toronto, who has pointed out in his classic 2010 HBR article, The Age of Customer Capitalism”, that there are in fact three different varieties of capitalism:

Managerial capitalism, where the managers try to balance a variety of goals, including making money but also serving other interests. (The doctrine of shared value can be seen as a variant of managerial capitalism.)

Financial capitalism, where the primary goal is maximizing shareholder value. Although even Jack Welch has called this the dumbest idea in the world, it is now pervasive in the Fortune 500. Private equity embodies financial capitalism. The advantage of financial capitalism is that it appears to make money in the short-term but the downside is that it encourages practices that ultimately destroy real shareholder value.

Customer capitalism: Drawing on the insight of Peter Drucker that “the only valid purpose of an organization is to create a customer,” the goal—and the bottom line—of the firm becomes that of adding value for customers. When this happens, as evidenced by companies like AppleApple [AAPL], Amazon [AMZN] and Salesforce [CRM], the firm ends up making more money than if it had adopted a goal of making money. As Jack Welch has pointed out, making money is the result, not the goal, of business.

According to Martin, the age of financial capitalism is coming to a close, self-destructing as a result of its steadily declining long-term returns and its ineffectiveness in the 21st Century marketplace where the balance of power has shifted from the seller to the buyer.

What is happening to the health sector is that it is becoming a victim of financial capitalism at the very moment that the era of financial capitalism is coming to a close. The hospitals owned by private equity are making money in the short-term at the expense of Medicare and the economy. But when the private equity firms depart, as they plan to do, they leave the hospitals with a load of debt, dispirited doctors and nurses, and a bankrupt Medicare system, with serious questions as to whether overall care has been maintained, let alone improved.

What is to be done?

The current bonanza for private equity from milking Medicare is a bubble that cannot be sustained. One answer is Government-run medicine. The other is a shift to what Martin calls customer or patient-centered capitalism where the focus is not on making money from providing more sick-care services but rather adopting the goal of providing ever-improving wellness for patients.

“We must shift the focus of companies back to the customer and away from shareholder value,” says Roger Martin in wonderful his book, Fixing the Game (2011). “The shift necessitates a fundamental change in our prevailing theory of the firm… The current theory holds that the singular goal of the corporation should be shareholder value maximization. Instead, companies should place customers at the center of the firm and focus on delighting them, while earning an acceptable return for shareholders.”

To accomplish this, firms must master the management principles needed for continuous innovation that delights customers and patients. To delight customers, a radically different kind of management needs to be in place, with a different role for the managers, a different way of coordinating work, a different set of values and a different way of communicating. This is not rocket science. It’s called radical management.

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Steve … I love ya, but this one misses a critical point: The definition of customer.

There are three customer-like roles: (1) true customers, who make buying decisions, (2) consumers, who use products and services, and (3) wallets, who pay for products and services.

When you buy something for yourself in a retail establishment, you take on all three roles, and market-based economics works.

In healthcare, it’s the seller that makes the buying decision (the individual doctor, clinic, or hospital) – the seller is the customer. The patient, meanwhile, is simply the consumer, while the insurance company is the wallet.

Market-based economics doesn’t work when the seller is the customer. It’s that simple.

Shifting to patient-centered capitalism sounds lovely, but as markets don’t work in healthcare, it’s little more than wishful thinking.

If you want to preserve a private-sector-driven model for healthcare, you need one that puts the patient in the customer and wallet roles as well as the consumer role. That’s going to take considerable innovation, and almost certainly some very serious government-driven incentives as well.

You write: “Markets don’t work in health care.” I am not sure that it is straightforward as that. We do not have fully open markets, but neither are markets irrelevant. It is true that the situation is complex because of the multiple parties involved.

However the current situation is bad and needs change. But not all change is positive. Private equity appears to be making the situation worse, by giving primacy to making money for itself, mainly by extracting money from Medicare and the hospitals and loading them up with debt.

We appear to be setting up another financial bubble that will in due course burst, with the government having to bail out the hospitals when they are unable to pay back their debts. Does any of this sound familiar?

I assert that it is possible to (1) improve patient care while (2) driving better financial results and (3) increasing employee satisfaction. But doing this requires thinking from a different perspective than “we can have one or two, but not all three.” Perhaps willing and active suspension of that constraint will allow for truly innovative thinking to achieve all three.